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Price Leak

Discounting prices is a common every-day occurrence for many manufacturing and distribution companies. In some industries, discounts are expected as a part of doing business on every transaction. The discount culture is manifested over years of practice by industry participants. To a great extent, as suppliers to a marketplace, we create these price discount cultures and encourage the practices by continually offering discounts at every turn.

On the upside, price discounts support revenue goals. On the downside, they cut profit margins. Maintaining a balance is crucial to maximize business performance.

Changing this culture doesn’t come easy. It takes time and commitment to adopt price integrity. That being said, discounts certainly have their place and should be used carefully to support revenue goals.

So, how do you know when you may be discounting excessively? We first look at sales teams and their behavior to get an indication on the extent of discounting. Often, the sales team is where the discount originates in an attempt to close a sale. Here are five situations where your sales team may be telling you that your price discounts are out of control.

· Do your sales reps have the authority to discount prices…even just a little?

· Are your reps compensated in whole or in part on the basis of their sales volume?

· Do reps tell you that your prices are too high?

· Do they ask for last minute discounts to close the deal?

· Do they give away free products or services?

If you answer YES to any or all of these, you may be losing a significant amount of profit margin through the sales organization. Unnecessary discounts at the sales level cost manufacturers and distributors an average of 2-4 margin points every year. In fact, we’ve seen companies lose as many as 10 margin points as a result of excessive discounting. Margin leaks at the sales level are one of the most over-looked and under managed threats to profitability.

Do you have a price discounting problem? Call the pricing consultants at PricePoint Partners to learn more about stopping price leaks and lifting margins.

Every manufacturer and distributor we have ever met has been leaking profit margin through pricing execution. Some leak just a little margin, while others are leaking a waterfall of profits that are never realized. These profit leaks are typically equal to 2 to 4 margin points – that is, $200,000 to $400,000 on every $10 million in revenue. In most cases, management is unaware of these leaks because they lack the awareness and visibility to identify where price leakage occurs.

A myriad of price leakage sources exist, including under-optimized prices, unrealized freight charges, insufficient recovery of handling costs and giveaways. You can begin to identify your leakage sources through four analyses that are relatively easy to execute provided you have access to historical pricing data taken from invoices. These simple starting points enable you to capture incremental pricing revenue that can fuel additional and more sophisticated analysis later. Starting points:

Take a careful look at negative-margin customer transactions. While most manufacturers and distributors believe that they have a handle on this issue, many are surprised to see how much business is being shipped at negative margins. We recently completed an analysis for a $100 million manufacturer who had over $250,000 in negative margin transactions. There were two choices for remediation: “fire” the customer or raise the price to an acceptable level. Either would stop the bleeding.

Extend your margin analysis to low-margin transactions. Determine the margin floor – that is, the minimum margin you are willing to accept. Identify all transactions that lie below this minimum, and adjust them to an acceptable level. Keep in mind that the margin floor is not a target; rather, it is your minimum threshold.

Small accounts are often a major source of margin leakage. Many of these accounts get low prices that should be reserved for much larger customers. Analyze which of these accounts are getting prices much lower than their peers. Look for price levels normally reserved for much larger accounts. Small accounts are rarely on management radar screen and tend to go unnoticed. Lifting prices on these accounts is low-risk and easy to execute.

Determine whether you are getting the most from high-value products. While commodity products may be the core of your business and require careful pricing attention, higher-value products that are customized or have a niche focus may be ripe for premium prices. Segment your product families into categories from commodity to high-value, and look closely at the respective pricing. Scale your price levels according to value, and ensure that your marketing and sales teams are effectively communicating the value.

Stopping price leaks can have a dramatic impact on your bottom line. And, getting started is relatively easy. For additional help in capturing margin through price leakage elimination, call the pricing experts at PricePoint Partners: 330-342-0923.

The majority of manufacturers and distributors use a cost-plus approach to pricing their products. In fact, McKinsey & Company research shows that over 63% of all manufacturers are still using a cost-plus pricing strategy. Unfortunately, while cost-plus is relatively easy to apply it tends to either leave money on the table or discourage sales by proposing prices that are, in the customer's view, too high.

That's not to say this "one size fits all" approach doesn't have a place in pricing. It is, in fact, very useful in setting price floors. However, that's where its usefulness ends. What you need is a process for determining optimal pricing - that is, the prices that maximize your profits and sales.

Start by recognizing that every sale is unique. Every buyer, customer, market and product has its own unique level of price sensitivity. The various combinations of these factors can result in hundreds or even thousands of individual profiles that determine what a customer is willing to pay. These individual profiles are known as price segments.

How do you identify and leverage these price segments? Assess each of the following fundamental factors:

The product - All products are not created equal. Some are commodities, where pricing decisions must be made with the competitive environment in mind. Margins are typically tighter on these products, which tend to be among a company's core offerings. On the other extreme are high-value products that are custom-built, contain proprietary content or feature a unique capability by the supplier. These products command higher prices in return for the higher value delivered. Between these endpoints lies a range of products of varying value offerings. The unique price sensitivity level of each of these products must be factored into the price-setting decision.

Markets and market segments - Each market has its own level of price sensitivity. The automotive OEM market is far more price sensitive than the oil and gas industry, for example. Recognizing these differences and adjusting prices accordingly is key to achieving price optimization.

Customer price sensitivity- This factor is critical to not only optimizing prices but also maximizing sales volume. Look at the customer's size in relation to its total spend with your firm. Larger customers have more buying power and typically require more competitive pricing while smaller customers can support higher pricing. In addition to customer size, factor in frequency of ordering, the number of special orders, buying skills and expertise, and the economic impact of the product on the customer's business.

Once you've taken these factors into account, you still may be challenged by not having a platform or architecture that enables you to set the myriad prices necessary to maximize your profits and sales. After all, your company is likely to have potential price drivers beyond the three mentioned here. Calculation and execution of your pricing strategy can become extremely complex.

Consider the real-world candy producer and distributor with 500 SKUs. With hundreds of customers and 10 different market segments and channels, this company's analysis revealed the need for more than 9,000 different prices to accommodate each potential pricing segment scenario. PricePoint Partners built a tool incorporating the required algorithms into a simple user interface so that the firm was able to easily identify and apply the very best price for every potential scenario.

We could help you as well. But the first step is up to you: recognizing which factors determine your price segments and beginning to apply the most significant ones to your business. Taking that first step away from cost-plus and toward an optimized pricing strategy will put you on the path to increasing your profit margins and company value.

We don’t typically think of pricing as a point of profit margin leakage. In fact, we tend to think of pricing as the one component that returns value to our company. A closer look at pricing can reveal some significant margin loss and is worth the time to analyze.

Take for example a recent pricing strategy case study of a high end professional service firm. This company has over 500 service-rendering professionals with annual sales of approximately $22 million. When we first approached this company as their pricing consultants, they insisted that their services were priced at the high end with very little discounting off of list.

One of the first things our price experts performed was a price analysis where we analyzed a history of their transaction data and found over 30 different discounts available to the service professionals to offer customers. While many of these had limits and specific application, many also less controlled. The damage? Just over $2 million was walking out the door each year with little to show in return. Management was shocked at the finding.

The company reeled in many of the unnecessary discounts and kept the ones that rewarded customer loyalty. In the end, $650,000 was retrieved with no loss in sales volume.

Look for price leaks in your freight, payment terms, handling fees, expedited shipping and other areas within the scope of pricing. Sealing these leaks usually means tightening and enforcement of policies. Pricing leaks are often the lowest hanging fruit in pricing improvement initiatives.

Contact Price Point Partners, a team of senior-level pricing experts dedicated to solving the most difficult pricing challenges of manufacturers, distributors and professional service providers since 1998. Call us at 330.342.0923 to speak with a pricing expert directly, or fill out our contact us form and whether you're looking to engage in our 1-Day Pricing Workshop pricing workshop, executive-level pricing strategy training or would like your own pricing analysis, we'll get back to you with the information you're requesting.